III. Third-Party and Affiliate Investment in BPL

F. Summary

In the OIR we proposed to allow third parties and utility affiliates to invest in BPL. We now adopt that preliminary conclusion. The OIR also recognized that if utility affiliates are investing in BPL, inappropriate cross-subsidization from ratepayers to utility affiliates should be prevented through the application of an appropriate set of affiliate transaction rules. The rules we adopt must protect against improper shifting of costs, but must not impose a regulatory burden that is unrelated to any potential harm.

To achieve these goals we order utilities to apply the affiliate reporting requirement adopted in D.93-02-019 (the Affiliate Reporting Requirements) to transactions between a utility and BPL affiliate. We do not apply the affiliate transaction rules contained in D.97-12-088, modified by D.98-08-035, and further clarified by D.98-11-027 (the Energy Affiliate Transaction Rules).

G. Third Party Investment

A BPL business model in which an independent third party builds, owns and operates a BPL system has sometimes been referred to as the "landlord-tenant" model, with the electric utility acting as the landlord by allowing a third party to install and operate a BPL system on the utility's facilities (i.e., the power lines, poles, and transformer enclosures). The utility and third-party BPL provider would negotiate a contractual arrangement by which the BPL provider would obtain access to the necessary utility infrastructure in exchange for some form of value flowing to the utility.

Ambient, Current, DOD/FEA, PG&E, SCE, SDG&E, and TURN endorse authorizing the electric utilities to allow third parties to invest in BPL. SCE states the following: "We also agree with the Commission's decision to promote a `landlord' model for electric utilities. At this point, SCE lacks the personnel and expertise to become a BPL provider itself. . . . The `landlord' model allows SCE to concentrate on its core business activities and shift responsibility and risk from the company to third parties." (SCE Opening Comments, p. 1.) As TURN points out, the landlord-tenant model offers a number of advantages, including alignment of ratepayer and shareholder incentives, access to BPL providers' technical and marketing expertise, true arms-length contract negotiations, a decrease in the need for regulatory oversight, and provision of the greatest potential ratepayer benefits. (TURN Opening Comments, pp. 5-8.)

UCAN, on the other hand, argues that allowing third parties to provide BPL services could complicate the utilities' ability to realize the "smart grid" benefits of BPL. Instead UCAN directs the Commission to further investigate the potential for direct utility provision of BPL with an emphasis on utility operational benefits. (UCAN Opening Comments, pp. 2 and 20.) Greenlining also prefers direct utility investment in BPL, rather than third-party investment, because it believes that the regulated utilities are better positioned to extend broadband to underserved communities. (Greenlining Reply Comments, pp. 4-5.)

We agree with SCE, TURN, and other parties that argue that companies unaffiliated with an electric utility should be permitted to invest in BPL. Third parties may have the risk appetite and operational experience that are most conducive to a successful roll-out of BPL. We also believe that allowing third party investment will be the most effective way to realize BPL's utility benefits and to extend broadband to underserved communities. Accordingly, we authorize an electric utility to allow an unaffiliated third party to own and operate a BPL system on its electric utility delivery system.

H. Utility Affiliate Investment

A second issue is whether a utility affiliates should be allowed to own and operate a BPL system. Concerns about utility affiliate provision of BPL services were advanced by CISPA, DisabRA, DRA, Time Warner Telecom, TURN, and UCAN. Most of these parties are concerned with the potential for improper cross-subsidization of the BPL affiliate by the utility. TURN argues that if the BPL vendor was a utility affiliate, that the "incentive compatibility between ratepayers and shareholders" that exists under the landlord-tenant model would be lost. (TURN Opening Comments, p. 8.) DRA also describes the "inherent conflicts of interest" between regulated public utilities and their affiliates. (DRA Opening Comments, pp. 15-16.)

Ambient, Current, PG&E, SCE, and SDG&E generally support allowing affiliate participation, and argue that cross-subsidization concerns are addressed by affiliate transaction rules. As PG&E states, "forbid[ing] utility affiliates from offering BPL, or impos[ing] severe restrictions on BPL affiliates, will unnecessarily restrict the pool of available companies that might offer BPL to Californians who might find it valuable." (PG&E Reply Comments, p. 13.)

In the past, the Commission has chosen to allow regulated utilities to have unregulated affiliates, and to address concerns about the relationship between the regulated and unregulated sides via affiliate transaction rules. We follow this precedent and authorize an electric utility to allow an affiliated company to own and operate a BPL system on its electric utility delivery system, subject to affiliate transaction rules.

I. Ratepayer Investment in BPL

Greenlining was the only party that advocated that the Commission investigate direct ratepayer investment in BPL for the purposes of providing broadband service. (Greenlining Reply Comments, pp. 4-5.) UCAN endorsed ratepayer investment primarily to achieve the "smart grid" benefits. (UCAN Opening Comments, p. 32.)

The focus of the OIR is not direct utility provision of BPL so no other parties commented on the possibility of utility investment in BPL as a rate base investment. Nonetheless, we briefly address these positions.

In the OIR, we stated that "the Commission intends to encourage BPL deployment in a manner that does not harm ratepayers." (OIR, p. 2.) We find that allowing rate base investment in BPL in inconsistent with this objective.

Several parties note that the ultimate commercial success of any particular BPL deployment is uncertain. (See e.g., SDG&E Opening Comment, pp. 2-3.) SCE, for one, notes the "very real potential [cable modem, DSL, and wireless broadband technologies] have to preempt BPL technology from ever developing into a new source of price and service competition." (SCE Reply Comments, p. 3.)

Even before commercial deployment, BPL faces technological challenges. Investors in BPL will face these competitive and technological risks. If BPL is commercially unsuccessful, a BPL company could lose significant sums of money. To the extent ratepayers pay for the incremental costs of deploying and operating a BPL network, ratepayers are assuming these financial risks.

Consequently we hold that a utility shall not make rate base investments in BPL if the BPL will be used for commercial broadband deployment. A utility may, however, invest in assets that make use of a BPL system provided that the investments can be justified on the basis of utility benefits.

The Commission will have the opportunity to review utility investments in assets that make use of a BPL system in General Rate Cases and in relevant proceedings. For example, any utility proposal to use BPL-based technology for advanced metering will be subject to review in the Commission's advanced metering proceedings.

A utility may purchase services from a BPL company provided that the costs can be justified by utility benefits. Such purchases would also be subject to review in General Rate Cases and through relevant proceedings. Additionally, any purchases of services from a BPL affiliate would be subject to affiliate transaction rules as discussed below.

J. Affiliate Transaction Rules

We decided above that we need rules to prevent inappropriate cross-subsidization from ratepayers to utility BPL affiliates. In the OIR that created this proceeding, we indicated that the Affiliate Reporting Requirements, as set forth in D.93-02-019, provide the necessary protections:

"To ensure that transactions between a utility and its affiliate do not harm ratepayers or subsidize BPL affiliates to the detriment of broadband competition, utility transactions with BPL affiliates would be subject to the same rules as a telephone utility's transactions with a DSL affiliate, as set forth in D.93-02-019. Transactions between the utility and its BPL affiliate would not be subject to the Affiliate Transaction Rules governing conduct between energy utilities and their energy affiliates since BPL is a communications platform that does not provide products that use electricity, or services that relate to the use of electricity.^25,26 (OIR at 11.)

The Affiliate Reporting Requirements are rules governing the reporting of transactions between electric, gas, and telephone utilities and their affiliates.

Ambient, AT&T California (AT&T), CCTA, and SDG&E support the OIR's preliminary conclusion that the Affiliate Reporting Requirements should apply to a utility's transactions with a BPL affiliate, and that the Energy Affiliate Transaction Rules should not be applied. SDG&E argues that the Affiliate Reporting Requirements lay out clear and understandable rules that provide for separate accounting and prevent cross-subsidization (SDG&E Opening Comments p. 23; SDG&E Reply Comments p. 21.) SDG&E proposes that affiliate transactions should occur on the basis of fair market value (SDG&E Opening Comments, p. 22).

SDG&E, in response to a question from the assigned ALJ at the PHC, also identified a specific and practical concern regarding the use of the Energy Affiliate Transaction Rules. Counsel for SDG&E stated the following:

SDG&E has spent and is spending several million dollars of shareholder money upon on a pilot. Now at this point in time, that's a risky thing to do because the rules are uncertain. Under some interpretations of the affiliate transaction rules that apply in the energy industry, the investment that is now being made by shareholders within the utility, the fruits of that investment could not be utilized by a BPL affiliate if the Commission decides to authorize such a business endeavor. (PHC Transcript, pp. 35-36.)

SDG&E, more generally, notes that many of the concerns related to interactions between a utility and energy affiliate do not apply to relationships between a utility and BPL affiliate. (SDG&E Opening Comments on Draft Decision, p. 8.)

SDG&E adds that applying the Energy Affiliate Transaction Rules to a potential BPL affiliate would place that affiliate at a competitive disadvantage in the broadband market. The affiliate would not only be a new entrant, but also would be subject to different rules than DSL providers. (SDG&E Reply Comments, pp. 20-21.)

SDG&E also notes that irrespective of which affiliate transaction rules the Commission applies, the Commission has the ability to scrutinize the relationships between a utility and BPL affiliate through other Commission rules.²⁷ (SDG&E Opening Comments on Draft Decision, p. 8.)

Ambient, AT&T, and CCTA similarly maintain that applying the Affiliate Reporting Requirements is appropriate from a competitive parity standpoint, since the telephone utilities must follow these rules with any transactions with a DSL affiliate. The telephone utilities are not subject to the Energy Affiliate Transaction Rules.

PG&E and SCE, on the other hand, argue that the Energy Affiliate Transaction Rules should apply to utility transactions with a BPL affiliate. PG&E and SCE maintain that, as energy utilities, they are familiar with the Energy Affiliate Transaction Rules, have employees trained to comply with those rules, and have compliance and reporting systems in place under those rules. (See, e.g., PG&E Reply Comments, pp. 13-14.) They also disagree with the conclusion of the OIR that the Energy Affiliate Transaction Rules are inapplicable because BPL is a communications platform, and is not a service "that relates to the use of electricity." (SCE Opening Comments, p. 8; PG&E Reply Comments, p. 14.)

DRA advocates for using the Energy Affiliate Transaction Rules too, but argued that parties should be permitted to present further testimony on the benefits and deficiencies of each set of rules, or a hybrid of the two. (DRA Reply Comments, p. 13.) DRA also recommends that if the Commission concludes that the Affiliate Reporting Requirements are the most appropriate set of rules, then additional rules should be adopted, such as those applied to Pacific Bell in D.87-12-067. (DRA Opening Comments, p. 15.)

The rules we adopt must protect against improper shifting of costs, but should not impose a regulatory burden that is unrelated to any potential harm. The choice before us cannot be over-simplified as a choice between a strict set of rules and a lax set of rules. The Commission has at different times applied the Energy Affiliate Transaction Rules or the Affiliate Reporting Requirements to protect ratepayers from subsidizing utility affiliates. The task before us is to choose the set of rules best suited for transactions with a BPL affiliate.

After reviewing these comments, we conclude that we should apply the Affiliate Reporting Requirements to transactions between a utility and BPL affiliate. The Affiliate Reporting Requirements provide strong ratepayer protections without imposing an unnecessary regulatory burden. Affiliate transactions will be subject to a "fair market value" standard. When reporting affiliate transactions pursuant to the Affiliate Reporting Requirements, utilities shall report the methodology used to calculate fair market value. The Commission will apply this standard when reviewing such affiliate transactions in a General Rate Case.

Application of the Affiliate Reporting Requirements will enable the Commission to exercise significant oversight over transactions between a utility and BPL affiliate. The Commission has found this to be the case in prior decisions including D.94-02-046, in which the Affiliate Reporting Requirements were applied to Time Warner AxS of California.

The Energy Affiliate Transaction Rules, on the other hand, were established to address a much broader range of concerns related to interactions between a utility and energy affiliate. We agree with SDG&E and other parties that to create a regulatory environment that does not place an unnecessary regulatory burden on BPL companies, the Energy Affiliate Transaction Rules should not be applied.

While PG&E and SCE prefer the Energy Affiliate Transaction Rules due to their familiarity with those rules, neither has shown current interest in creating an affiliate to provide BPL services. Thus, the choice of affiliate rules is of less immediate consequence to these companies.

²⁵ The Commission adopted Affiliate Transaction Rules in D.97-12-088, modified by D.98-08-035, and further clarified by D.98-11-027.

²⁶ This is consistent with D.00-06-019, in which the Commission concluded that the energy Affiliate Transaction Rules did not apply to transactions between a communications utility affiliate and the regulated utility since the communications affiliate did not offer "energy-related" products or services.

²⁷ For example, Pub. Util. Code § 314 states, in relevant part, that "The commission, each commissioner, and each officer and person employed by the commission may, at any time, inspect the accounts, books, papers, and documents of any public utility. . . . [This rule] also applies to inspections of the accounts, books, papers, and documents of any business which is a subsidiary or affiliate of, or a corporation which holds a controlling interest in, an electrical, gas, or telephone corporation with respect to any transaction between the electrical, gas, or telephone corporation and the subsidiary, affiliate, or holding corporation on any matter that might adversely affect the interests of the ratepayers of the electrical, gas, or telephone corporation"; see also § 451 requiring that all charges demanded by a public utility be just and reasonable, § 587 requiring the reporting of affiliate transactions, § 701.5 limiting the pledging of utility assets, and § 797 requiring the Commission to periodically audit affiliate transactions.